Is inequality a threat to capitalist system?

Free-market capitalism is a success because it does the most efficient possible job of allocating a society’s resources, or so goes the prevailing logic.

But what if capitalism’s true value lies elsewhere? What if its most important attribute is actually inefficiency?

That’s the provocative and surprisingly compelling argument recently put forth by venture capitalist Nick Hanauer and economist Eric Beinhocker of the Institute for New Economic Thinking. If they’re right, rising socioeconomic inequality may represent a threat to the creative engine of capitalism itself.

Much of modern economics rests on the notion that price is the best measure of worth. Economists decided half a century ago that the value of something is best reflected in the marketplace: How much is someone willing to pay for it? Accept this way of thinking, and it’s natural to take gross domestic product, measured in dollars, as the best indicator of a society’s wealth and prosperity – perhaps with some adjustments to account for more subtle things such as human well-being.

But is it enough just to tweak how we put monetary values on things? What we need, Hanauer and Beinhocker suggest, is a more radical rethink. We need to begin seeing wealth not merely as money, but as a solution to human problems.

It’s obvious if you think about it. If someone gave you a billion dollars and sent you to the Democratic Republic of Congo, or any of the other poorest nations on Earth, you would be able to buy anything available there in far larger amounts than what the locals could afford. Yet, you’d be a lot less wealthy than the average person in any developed nation, because you would lack access to solutions: safe food and water, reliable electricity, trustworthy police and other institutions. Monetary wealth may be correlated with solution-based wealth, but the solutions matter most.

Begin seeing things this way, and capitalism starts looking a bit different. Market-based economies do seem to create prosperity more effectively than the alternatives, but the secret of their success doesn’t look much like an optimal equilibrium.

They thrive precisely because of their capacity to generate innovative disruption. Like a Darwinian evolutionary system in which only the fittest survive, they foster perpetual disequilibrium, test myriad new possibilities, and thereby discover and foster new solutions. The process involves a lot of failure and waste. How many startups crash and burn for each one that changes our lives?

This brings Hanauer and Beinhocker to a crucial point: The creativity required for capitalism to function demands diversity. It needs many minds exploring in different directions, bringing varied skills and experience to bear in testing a multitude of potential solutions.

From this perspective, the biggest problem with the recent dramatic rise in socioeconomic inequality – as surveyed most recently by economist Thomas Piketty – may be the way it erodes the pool of humans who receive the education and resources necessary to play a role in capitalist creativity. Inequality restricts access to the store of human solutions to the few, reducing the chance for hundreds of millions of minds to contribute as they otherwise could.

To put it bluntly, how many powerful new solutions can we expect from tax breaks for the 1 percent? Given the rarity of really good new ideas, those who have already achieved success may be the least likely to find them – to be the “job creators” of the future. By contrast, broad investments in public health and education across 350 million people might be decisive in nurturing the creative base of the nation.

The contribution of Hanauer and Beinhocker is important because it goes beyond the old stereotypes and easy cliches about why capitalism really works. The secret is messy, wasteful, creative exploration, not some mysterious equilibrium. We need everyone, rich and poor, to make it work.

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